Reversing the Null: Regulation, Deregulation, and the Power of Ideas

by David Moss

Executive Summary — Who's to blame for the recent financial crisis? To some extent, the fault lies with scholars of economics, according to professor David Moss. In this paper, he argues that an academic focus on government failure in the second half of the 20th century led to the general idea that less was always more when it came to regulation--which, in part, contributed to the crisis. To that end, he calls for a fundamental shift in academic research on the government's role in the economy. Key concepts include:

By shifting their focus from market failure to government failure, late-20th-century scholars of economics helped create the impression that government can't get anything right. This helped set the stage for a widespread deregulatory mindset.

This mindset was important in helping to eliminate unnecessary regulation, but it also hampered the creation of vital new regulation--including regulation of the largest and most "systemically significant" financial institutions--that might have prevented the financial crisis in the first place.

The existing null, that government is perfect, has prompted a great deal of work on government failure. Now, Moss suggests, it's time for scholars to try to gain a deeper understanding of when government succeeds and under what conditions. How can well-known sources of government failure, such as regulatory capture, be prevented or minimized? To get there, he says, scholars need to adopt a new null hypothesis--namely, that government always fails. As scholars go about trying to reject that null, they are likely to generate valuable new research on government and regulation, including what works, what doesn't, and why.

Author Abstract

It has been said that deregulation was an important source of the recent financial crisis. It may be more accurate, however, to say that a deregulatory mindset was an important source of the crisis--a mindset that, to a very significant extent, grew out of profound changes in academic thinking about the role of government. As scholars of political economy quietly shifted their focus from market failure to government failure over the second half of the twentieth century, they set the stage for a revolution in both government and markets, the full ramifications of which are still only beginning to be understood. This intellectual sea-change generated some positive effects, but also some negative ones, including (it seems) an excessively negative impression of the capacity of government to address problems in the marketplace. Today, as we consider the need for new regulation, particularly in the wake of the financial crisis, another fundamental shift in academic thinking about the role of government may be required-involving nothing less than a reversal of the prevailing null hypothesis in the study of political economy.